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Board independence corporate cash, page 1

Board independence and corporate cash holding

Hoontaek Seo

Niagara University

Daniel L. Tompkins

Niagara University

Sangho Yi

Sogang University

ABSTRACT

The enactment of the Sarbanes-Oxley Act (SOX hereafter) and the contemporaneous change of

exchange listing rules in 2002 creates a natural experiment for the examination of the effect of board

independence on corporate cash holding practices and value of cash to shareholders. Findings include that

firms that are driven to take on a majority of independent directors on the board increased their cash

holdings and experienced higher value of cash to shareholders after the SOX. The increase in cash

holding is smaller in the firms which were financially constrained and firms which were subject to high

degree of external monitoring.

Keywords: Sarbanes-Oxley Act, Corporate Governance, Board Structure, Corporate Cash Holding, Value

of Cash

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INTRODUCTION

The enactment of the Sarbanes-Oxley Act (SOX hereafter) and the contemporaneous change of

exchange listing rules in 2002 creates a natural experiment for the examination of the effect of board

independence on corporate cash holding practices and value of cash to shareholders.

In the perfect capital market, cash holding is a zero net present value investment and a firm’s

decision about how to use internal funds do not affect firm value since firms can freely access the capital

market to finance any positive net present value project without any friction (Modigliani and Miller

(1958)). However, this value irrelevance proposition of Modigliani and Miller is frequently violated in

reality. When a firm seeks external financing, it has to bear sizable transaction costs arising from several

ubiquitous factors including information asymmetry, taxes and bankruptcy costs in the actual capital

market. Thus, a firm’s cash holding practices may have significant value consequences.

Theory of the firm suggests another within-a-firm channel whereby a firm’s cash holding

practices may influence firm value. As a nexus of contracts, conflicts of interest between upper-level

managers and shareholders are common within a firm (Jensen and Meckling (1976)). While these

managers are contractually liable to maximize shareholders’ wealth, they often have strong preferences

for increasing their own utility at the expense of shareholders unless effective corporate governance

circumvents managers’ opportunistic behavior diverging from shareholders’ interests. Likewise, effective

corporate governance may limit a manager’s ability to pursue private benefits by squandering cash at her

discretion (Jensen (1986); Stultz (1990)), increasing value of cash to shareholders.

Previous studies report inconsistent evidence on the aforementioned relationship between

corporate governance, corporate cash holding practices and value of cash to shareholders. For example,

Dittmar and Mahrt-Smith (2007) show that the value of excess cash is reduced when firms are poorly

governed. They also show that poorly governed firms spend excess cash more quickly on less profitable

investments relative to firms with good corporate governance. Pinkowitz, Stultz, and Williamson (2006);

and Kalcheva and Lins (2007) provide similar evidence in their cross-country analysis. On the other hand,

Opler, Pinkowitz, Stultz and Williamson (1999) find that there is no significant relationship between

corporate cash holding practices and firm-level corporate governance. Thus, a causal relationship between

corporate governance and corporate cash holding practices is still not clear in the previous literature and is

still an open empirical question.

This paper revisits this issue by taking advantage of the SOX as a natural experiment. The SOX is

an interesting avenue of inquiry on this issue for the following reasons. The SOX provides a useful

laboratory since, after the passage of the SOX, the New York Stock Exchange (NYSE) and NASDAQ

amended their listing standards to raise the required percentage of independent directors on corporate

boards (Chhaochharia and Grinstein (2009)). Guo and Masulis (2012) conclude that monitoring becomes

more effective with a greater representation of independent directors on a board. This research uses the

difference-in-difference methodology, and compares the changes of corporate cash holdings and value of

cash to shareholders after the SOX for firms which had a minority of independent directors on the board

in the pre-SOX period with those of the firms which had a majority of independent directors on the board

in the pre-SOX period.

The overall results support the hypothesis that board independence significantly affects corporate

cash holding practices and increases value of cash to shareholders. First, previous research finds that

firms which had a minority of independent directors on the board in the pre-SOX period increased their

cash holdings in the post-SOX period relative to firms which had a majority of independent directors on

the board in the pre-SOX period. This finding suggests that improved board monitoring motivates firms

to hold larger cash reserves since improved board monitoring allows firms to adopt more flexible cash

holding practices. Especially, firms whose boards consisted predominately of nonindependent directors

on the board in the pre-SOX period are critically affected by new listing standards resulting from the SOX.

Second, the effect of board independence on corporate cash holding practices was weaker for financially

constrained firms than for financially unconstrained firms. This finding further confirms the hypothesis

that improved board monitoring motivates firms to hold larger cash reserves since managers of financially



constrained firms are less able to squander their cash reserves and the effects of improved board

monitoring on corporate cash holding practices are expected to be smaller for these firms. The third result

is that the positive relationship between board independence and corporate cash holdings is smaller for

firms which were subject to intense external monitoring. The results imply that board independence and

external monitoring seem to act as substitutes to each other. Finally, the value of additional dollar of cash

increased in the post-SOX period in firms which didn’t have a majority of independent directors on the

board in the pre-SOX period relative to the value of additional dollar of cash in firms which had a

majority of independent directors on the board in the pre-SOX period. The result implies that improved

board monitoring increases the value of additional dollar of cash.

This paper contributes to the literature in several significant ways. First, it provides endogeneity-

free evidence that board independence leads to more flexible corporate cash holding practices and greater

value of cash to shareholders. Clear evidence on the causal relationship between board independence and

corporate cash holding practices is still scarce in the extant literature. The research exploits a unique

feature of the SOX to isolate a shock to corporate boards enhancing board independence. Second, taking

advantage of the SOX as a natural experiment, the research provides evidence on the substitutability

between internal and external corporate governance mechanisms. Improvement in internal corporate

governance mechanism impacts corporate cash holding practices only when the firm is subject to weak

external monitoring. Direction of the interaction between internal and external governance mechanisms is

not obvious ex ante but understanding how internal governance mechanisms interact with external

governance mechanisms is necessary when one views corporate governance of a firm as a portfolio of

internal and external governance mechanisms (Barber and Liang (2008)).

The remainder of this paper proceeds as follows. Developing the main hypothesis is first,

followed by a description of the data and sample. Third, the paper provides the empirical results. Last is

the conclusion.

HYPOTHESES DEVELOPMENT

This section develops several hypotheses concerning the causal relationship between board

independence and corporate cash holding practices.

Agency theory predicts that self-interested managers are more likely to squander excess cash

reserves in the present to fund pet projects or consume perquisites rather than hold them for future

investment (Jensen and Meckling (1976); Harford, Mansai and Maxwell (2008)). Furthermore, John and

Knyazeva (2006) suggest that poorly governed firms may choose to rely on pre-commitment to dividend

payments for the purpose of diluting significant managerial moral hazard problem due to poor corporate

governance, which results in small cash reserves maintained by such firms. On the other hand, Stultz

(1990) and Harford, Mansai and Maxwell (2008) suggest that good corporate governance may increase

corporate cash holding since shareholders who are aware of diluted managerial moral hazard problem due

to good corporate governance allows managers to hold larger cash reserves for the purpose of overcoming

underinvestment problem in the presence of costly frictions in the external financing. The aforementioned

arguments lead to the following hypothesis:

H1. Firms which have a minority of independent directors on the board in the pre-SOX period

would increase their cash holdings in the post-SOX period relative to firms which had a majority of

independent directors on the board in the pre-SOX period.

As a firm is financially more constrained, a manager’s ability to squander excess cash reserves to

seek private benefits and consume perquisites will be limited. Furthermore, cash holdings are more

valuable to financially constrained firms since for these firms external financing is more costly, which

aggravates costs of manager’s squandering cash for private benefit seeking (Denis and Sibilkov (2010)).

Therefore, the effect of board independence on corporate cash holding practices will be smaller for

financially constrained firms. Thus the paper investigates the hypothesis:

H2. For firms which were more financially constrained, the aforementioned effect of the

independent directors on corporate cash holding in H1 would be smaller.



Chhaochharia and Grinstein (2009) explain that the monitoring role of independent directors

could be well established by investigating the interaction between board independence and external

monitoring by block-holders, public pension funds or the market for corporate control. Harford, Mansi,

and Maxwell (2008) show that anti-takeover provisions are negatively related to corporate cash holdings

and institutional ownership is positively related to corporate cash holdings. If such external monitoring

substitutes for monitoring needs by independent directors, the board independence should not have an

effect on the corporate cash holdings in firms subject to intense external monitoring. These arguments

lead to the following hypothesis:

H3. For firms which were subject to high degree of external monitoring, the aforementioned

effect of the board independence on corporate cash holding in H1 would be smaller.

Dittmar and Mahrt-Smith (2007) show that an extra dollar of cash is less valuable to shareholders

at poorly governed firms. Thus, one could expect that an extra dollar of cash would be more valuable to

shareholders in the post-SOX period at firms that didn’t have a majority of independent directors on the

board in the pre-SOX period relative to the shareholders at firms that had a majority of independent

directors on the board. Thus the final hypothesis:

H4. The value of additional dollar of cash increased in the post-SOX period in firm which didn’t

have a majority of independent directors on the board in the pre-SOX period relative to the value of

additional dollar of cash in firms which had a majority of independent directors on the board.

DATA AND DESCRIPTIVE STATISTICS

RiskMetrics (formerly called IRRC) provides the data on boards of directors. The database

contains directors’ information of S&P 1500 firms. Accounting data is obtained from Compustat, the

stock return from CRSP, the Gompers, Ishii and Metrick (2003) index from RiskMetrics and

shareholdings by institutional investors from Thomson’s 13f filings database.

The sample spans from the year 1996 to 2006. The sample begins in 1996 since the board data is

available since 1996. The sample consists of all US firms which have complete (no missing) data on

director independence data on RiskMetrics in 2001 to determine whether a firm is affected or unaffected

by the regulation. Consistent with the previous literature, such as Liu and Mauer (2011) and Guo and

Masulis (2012), excluded firms include those in the financial service industries (SIC 6000-6999) and in

the utility sector (SIC 4900-4999). The firms are required to be listed on NYSE or NASDAQ from 2001

until 2004 to make sure that firms are subject to the regulation and the results are not driven by firms

entering or leaving the sample before or after the implementation of regulation. The final sample of firms

is comprised of 849 firms with 8059 firm-year observations.

Following Guo and Masulis (2012), Firms are identified as affected by the new listing rules

according to their board structure in the year 2001. The NYSE and NASDAQ required firms with

nonclassified boards to abide by the new listing rules during their first annual meeting between January

15, 2004 and October 31, 2004. For firms with classified board, the compliance deadline is the second

annual meeting between January 15, 2004 and December 31, 2005. However, many firms began to

change their board structure before the compliance deadlines. Guo and Masulis (2012) argue that board

structure “in year 2001 [represents] the most recent board structures that were not influenced by

[anticipation] of new listing rules.”

A firm is placed in a treatment group for not meeting the terms of the new listing rule on board

independence in year 2001; otherwise to a control group. The percent of independent directors on a board

determines board independence. As noted by Bradley and Chen (2009) “RiskMetrics’ independence

standard is higher than [that of] NYSE and NASDAQ:”

“First, NYSE and Nasdaq define former employees as independent if three years has

passed since their employment in the firm ended, while RiskMetrics considers all former

employees non-independent. Second, the NYSE and Nasdaq definition allows for the

existence of “insignificant” business relations between independent directors and the firm,



while RiskMetrics considers any director with a business relation as non-independent.

Hence, what is considered by NYSE and Nasdaq to be an independent director may be

considered as linked (gray)director according to the RiskMetrics definition.” (Guo and

Masulis, 2012)

Following Chhaochharia and Grinstein (2009), nonindependent directors are reclassified as

independent directors if they were former employees of a firm and at least three years have passed since

the termination of their employment. However, nonindependendent directors cannot be reclassified as

independent directors if their business transactions are insignificant since the size of the business

transactions are not observed. Thus, the adjusted standard is still higher than that of NYSE and NASDAQ.

Panel A in Table 1(appendix) reports the summary statistics for the characteristics of the firms in

the full sample. The mean and median value of percent of independent directors is 69.05% and 71.43%

respectively, well over the majority requirement. Panel B of Table 2 (Appendix) compares the

characteristics of the firms with a minority percentage of independent boards (treatment firms), with those

of the firms with majority independent boards (control firms) in year 2001. The researchers also report p-

values of t-tests for differences in means of the treatment and control firms. The mean value of percent of

independent directors for treatment firms is 36.10%, while the mean value of percent of independent

directors for control firms is 72.02%. The difference is highly significant at 1% level. The treatment firms

on average have smaller boards, smaller total assets, smaller sales and lower leverage than control firms.

However, p-values show that treatment firms are not significantly different from control firms in terms of

cash holdings and market to book ratio.

RESULTS

Board Independence and Cash Holdings

To examine the effect of board independence on a firm’s cash holding, the research uses the

following difference-in-difference (DID) specification:

Cash Holdingsit = 1

× Dummy(perind < 0.5 ′01)i × Post_SOX

+[2

× 𝐷𝑢𝑚𝑚𝑦(𝑖𝑛𝑑𝑎𝑢𝑑𝑖𝑡 = 0 ′01)𝑖 × 𝑃𝑜𝑠𝑡_𝑆𝑂𝑋

+3

× 𝐷𝑢𝑚𝑚𝑦(𝑖𝑛𝑑𝑐𝑜𝑚𝑝𝑒𝑛𝑠𝑎𝑡𝑖𝑜𝑛 = 0 ′01)𝑖 × 𝑃𝑜𝑠𝑡_𝑆𝑂𝑋

+4

× 𝐷𝑢𝑚𝑚𝑦(𝑖𝑛𝑑𝑛𝑜𝑚𝑖𝑛𝑎𝑡𝑖𝑜𝑛 = 0 ′01)𝑖 × 𝑃𝑜𝑠𝑡_𝑆𝑂𝑋]

+5

𝑋𝑖𝑡 + 𝑖𝑡 (1)

In the above specification, 𝐶𝑎𝑠ℎ 𝐻𝑜𝑙𝑑𝑖𝑛𝑔𝑠𝑖𝑡 is firm i’s cash holdings at year t. 1 is the change in

the cash holdings of the firms which had a majority of nonindependent directors on the board at 2001 in

the post-SOX period compared to the cash holdings of the firms that had a majority of independent

directors on the board at 2001. 1 is the primary coefficient of interest. 𝐷𝑢𝑚𝑚𝑦(𝑝𝑒𝑟𝑖𝑛𝑑 < 0.5 ′01)𝑖 is a

dummy variable that equals to one if the firm did had a majority of nonindependent directors on the board

in 2001, and zero otherwise. 𝑃𝑜𝑠𝑡 − 𝑆𝑂𝑋 is a dummy that equals to one if year t is 2003 or thereafter,

and zero otherwise. As in Liu and Mauer (2011), also included is the interaction terms listed in the

brackets to account for the effects of committee independence on cash holdings. 2(3,4) represent the

change in the cash holdings of the firms whose audit (compensation, nomination) committees were not

fully independent at 2001 in the post-SOX period compared to the cash holdings of the firms who had

fully independent audit (compensation, nomination) committee. Dummy(ind_audit=0 ’01)i (Dummy(ind_

compensation=0 ’01)i, Dummy(ind_nomination =0 ’01)i) is a dummy variable that equals to one if the

firm did not have a fully independent audit (compensation, nomination) committee on the board in 2001,

and zero otherwise.



The control variables in the cash holdings regressions are motivated by the variables used in Liu

and Mauer (2011). The control variables are as follows: log firm size is measured by natural logarithm of

the book value of net assets measured in 2006 dollars; market-to-book asset ratio is computed as the ratio

of the book value of net assets minus the book value of equity plus the market value of equity to the book

value of net assets; cash flow/net assets is calculated as the ratio of earnings after interest, dividends and

taxes but before depreciation to the book value of net assets; NWC/assets is the ratio of net working

capital to the book value of net assets; capex/net assets is the ratio of capital expenditures to the book

value of net assets; leverage is computed as the sum of long-term debt and debt in current liabilities

divided by the book value of net assets; industry sigma is measured by the mean of the standard

deviations of cash flow/net assets over 10 years for firms in the same industry, where industries are

defined by two-digit SIC codes; dividend dummy is an indicator variable that equals to one in years in

which a firm pays a common dividend and zero otherwise; R&D/sale is the ratio of research and

development expenditure to sales. If research and development expenditure is missing, the ratio is set

equal to zero; acquisition activity is measured by the ratio of expenditures on acquisitions to the book

value of net assets; related debt dummy is an indicator variable that equals one if S&P credit rating is

between "C" and "AAA" and zero otherwise. All continuous variables are winsorized at the 1st and 99th

percentiles to mitigate the effect of outliers. Following Chhaochharia and Grinstein (2009), each control

variable interacts with two dummy variables for whether the observation belongs to pre-SOX (at or before

2002) period or post-SOX (2003 or thereafter) period to explain any potential change in cash holdings for

all firms as a consequence of the corporate scandals. The estimation includes firm fixed effects, year fixed

effects and industry fixed effects. In all the regressions, standard errors are adjusted for heteroscedasticity.

Table 2 reports the results of DID regressions of cash holdings on increases in board

independence after the SOX. The coefficient on interaction term on Dummy(pct_ind<0.5 '01) is

significantly positive in column 1, implying that firms which didn’t have a majority of independent

directors on the board in the pre-SOX period increased their cash holdings in the post-SOX period relative

to firms which had a majority of independent directors on the board in the pre-SOX period. The result is

consistent with hypothesis 1. In Model 2 of Table 2, added are the three additional interaction terms on

committee independence as in equation (1). The interaction term on audit committee is significantly

positive. The result also shows that the nominating committee is not significantly associated with cash

holdings. Interestingly, the coefficient on the interaction term on compensation committee is significantly

negative. However, this is consistent with Guthrie, Sokolowsky, and Wan (2012). They document that the

compensation committee independence requirement increases CEO total pay.

Board Independence and Cash Holdings Conditional Upon Financial Constraints

This paper also examines how the effect of board independence on corporate cash holdings

depends on financial constraints. Firms that are more financially constrained have less cash to waste.

Thus these firms are less likely to waste their cash and the effect of board independence on corporate cash

holdings will be smaller than for firms that are less financially constrained. Following the literature (see

e.g. Harford, Kecskés, and S. Mansi (2012)), the research uses four proxies for financial constraints: the

total payout ratio, total assets, bond rating status, and commercial paper rating status. Firms are classified

as constrained if their total payout ratio is zero; if the firm does not have a bond rating but reports long-

term debt; if the firm has no commercial paper rating but reports short-term debt; or if the firm’s total

assets are below the sample median; otherwise firms are classified as unconstrained. To examine whether

financial constraints influence the effect of board independence on corporate cash holdings,

Dummy(pct_ind<0.5 '01) and Post-SOX interact with proxy variables for financial constraints. Negative

coefficients on these triple interaction variables would indicate that the positive effect of board

independence on corporate cash holdings is less positive for financially constrained firms than for firms

that are not financially constrained.

Table 3 (Appendix) reports the results of DID regressions of cash holdings which interacts

Dummy(pct_ind<0.5 '01) and Post-SOX with a dummy variable for whether the firm has zero total



payouts in Model 1, a dummy variable for firms that do not have a bond rating but report long-term debt

in Model 2, a dummy variable for firms that have no commercial paper rating but report short-term debt

in Model 3, and a dummy variable for firms whose total assets are below the sample median in Model 4.

The primary interest variable is the triple interaction variables. The coefficient on these triple interaction

variables in Model 2 and 3 are significantly negative. This implies that the effect of board independence

on corporate cash holdings is less positive for financially constrained firms than for financially

unconstrained firms. This result is consistent with hypothesis 2.

Board Independence and External Monitoring

Independent boards are internal means to control agency problems. There could be also external

pressure to reduce the agency problems from institutional investors or from the market for corporate

control. Specifically, Harford, Mansi, and Maxwell (2008) show that anti-takeover provisions are

negatively related to corporate cash holdings and institutional ownership is positively related to corporate

cash holdings. To the extent that such external monitoring substitutes for monitoring needs by

independent directors, the board independence should not have an effect on the corporate cash holdings in

firms that have external monitoring in place.

Similar to Kim and Purnanandam (2006), three proxies for external pressure/monitoring and

analyze are used: shareholdings by institutional block-holders; shareholdings by public pension funds;

anti-takeover index of Gompers, Ishii and Metrick (2003). two dummy variables are created for external

monitoring. Low Monitoring equals one for firms that fall in the bottom quartile of respective monitoring

dimension, and zero otherwise. High monitoring equals one for firms that fall in the top quartile of

respective monitoring dimension, and zero otherwise. To analyze how external monitoring influences the

effect of board independence on corporate cash holdings, the research interacts Dummy(pct_ind<0.5 '01)

and Post-SOX with proxy variables for external monitoring.

Table 4 reports the results of DID regressions of cash holdings which interacts

Dummy(pct_ind<0.5 '01) and Post-SOX with proxy variables for external monitoring. The research uses

shareholdings by institutional block-holders as the proxy for external monitoring in Model 1,

shareholdings by public pension funds as the proxy for external monitoring in Model 2, and anti-takeover

index of Gompers, Ishii and Metrick (2003) as the proxy for external monitoring in Model 3. The results

provide evidence that board independence does not have explanatory power for firms that are subject to

high degree of external monitoring in all Models. The research finds a positively significant relationship

between board independence and corporate cash holdings only in firms that belong to the bottom quartile

of respective monitoring dimension. The results imply that the existence of high degree of external

monitoring reduces the importance of board independence for corporate cash holdings decision. In fact,

board independence and external monitoring seem to act as substitutes to each other.

Board Independence and the Value of Cash

The methodology developed in Faulkender and Wang (2006) is used to estimate impact of board

independence on the value of an additional dollar of cash to equityholders. The regression equation is

specified as follows:

ri,t − Ri,tB =

0+

1

Ci,t

Mi,t−1+

2Post_SOX +

3Dummy(perind < 0.5 ′01)i

+4

Dummy(perind < 0.5 ′01)i × Post_SOX + 5

Post_SOX ×Ci,t

Mi,t−1



+6

Dummy(perind < 0.5 ′01)i × Post_SOX ×Ci,t

Mi,t−1+

7

Ei,t

Mi,t−1

+8

NAi,t

Mi,t−1+

9

RDi,t

Mi,t−1+

10

Ii,t

Mi,t−1+

11

Di,t

Mi,t−1+

12

Ci,t

Mi,t−1+

13Li,t

+14

NFi,t

Mi,t−1+

15

Ci,t

Mi,t−1×

Ci,t

Mi,t−1+

16Li,t

Ci,t

Mi,t−1+ i,t

(2)

where ∆Xit indicates a change in variable X for firm i over year t-1 to year t. To avoid having the largest

firms dominate the results, the 1-year lagged market value of equity (𝑀𝑖,𝑡−1) is used as the scaling

variable. The independent variable include: cash and marketable securities (Ci,t), earnings before

extraordinary items (Ei,t), net assets (NAi,t), research and development expense (RDi,t), interest expense

(Ii,t), common dividends (Di,t), long-term debt plus in current liabilities divided by the market value of

equity at time t-1 (Li,t), and net financing (NFi,t). The dependent variable is the excess stock return, the

difference between firm i’s stock return during fiscal year t (ri,t) and the stock i's benchmark return at year

t (𝑅𝑖,𝑡𝐵 ). The research calculates the benchmark return by annualizing the monthly returns from the Fama

and French (1993) 25 size and book-to-market portfolio the firm belongs to each month. The regression is

run as OLS with robust standard errors. 6 is the primary coefficient of interest. 6 measures the change in

the value of an additional dollar of cash for firms that did not have a majority of independent directors on

the board at 2001 in the post-SOX period compared to the value of an additional dollar of cash for firms

that had a majority of independent directors on the board at 2001 in the post-SOX period.

Table 5 reports the result of DID regression of the value of additional dollar of cash on board

independence. The triple interaction variable is of primary interest. The coefficient on this triple

interaction is significantly positive. This result suggests that the value of additional dollar of cash

increased in the post-SOX period in firms which didn’t have a majority of independent directors on the

board in the pre-SOX period relative to the value of additional dollar of cash in firms which had a

majority of independent directors on the board in the pre-SOX period. The findings support hypothesis 4.

CONCLUSIONS

This paper investigates how board independence affects corporate cash holding practices and

value of cash to shareholders using the SOX as a natural experiment. Empirical studies of corporate

governance are known to suffer from pervasive endogeneity problems since unobservable factors, which

are not controlled for in regressions, may cause spurious correlation between corporate governance

variables and corporate cash holding practices (Gompers, Ishii and Metrick, 2003). Taking advantage of

the SOX, provides for endogeneity-free evidence that improved board monitoring leads to increased cash

holdings and higher value of cash to shareholders. Further, the effect of board independence on cash

holdings is smaller in the firms which were financially constrained and firms which were subject to high

degree of external monitoring.



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http://dx.doi.org/10.2139/ssrn.1146922

http://dx.doi.org/10.2139/ssrn.2000226



Table 1: Summary Statistics and Comparison of Treatment and Control Firms in Year 2001

This table shows the summary statistics for the characteristics of the firms in the full sample and comparison of the

characteristics of the firms between treatment and control firms in year 2001. The full sample consists of 849 firms

from 1996 to 2006. Panel A reports the summary statistics for the characteristics of the firms in the full sample.

Panel B compares the characteristics of the firms with less than majority independent boards (treatment firms), with

those of the firms with majority independent boards (control firms) in year 2001. Column (3) contains p-values of t-

tests for differences in means of the treatment and control firms. Percent of independent directors is calculated as

(number of independent directors/the board size) x 100. Board size is the number of directors on board. Cash

holdings is the ratio of cash plus marketable securities to net assets, where net assets is the book value of total assets

minus cash plus marketable securities. Market to Book is the ratio of the market value of total assets to the book

value of total assets. Leverage is the ratio of long term debt plus debt in current liabilities to the book value of total

assets.

Panel A: Summary Statistics

Mean 1st Quartile Median 3rd Quartile Std. Dev. N

Percent of independent directors 69.05 58.33 71.43 81.82 16.50 8059

Board size 9.33 8.00 9.00 11.00 2.51 8059

Cash holdings 0.23 0.02 0.07 0.23 0.41 8059

Total Assets ($ mil) 6821.81 662.86 1533.21 4297.30 26547.12 8059

Sales ($ mil) 6130.96 668.14 1565.26 4597.02 17352.16 8059

Market to Book 2.16 1.26 1.66 2.45 1.62 7320

Leverage 0.22 0.07 0.21 0.33 0.17 8034

Panel B: Comparison of Treatment and Control Firms in Year 2001

(1)Control (2)Treatment (3)P-value

Percent of independent directors 72.02 36.10 0.00

Board size 9.16 8.57 0.03

Cash holdings 0.23 0.28 0.40

Total Assets ($ mil) 7015.70 2454.10 0.00

Sales ($ mil) 5862.20 2467.30 0.00

Market to Book 2.16 2.17 0.95

Leverage 0.23 0.20 0.09

N 746 103



Table 2: Board Independence and Cash Holdings

This table shows the results of regressions of cash holdings on board independence. The sample includes all the firm

years from 1996 to 2006 in the full sample. The dependent variable is the ratio of cash plus marketable securities to net

assets, where net assets is the book value of total assets minus cash plus marketable securities.

Dummy(pct_ind<0.5 ’01) is a dummy variable that equals to one if the firm did not have a majority of independent

directors on the board in 2001, and zero otherwise. Dummy(ind_audit=0 ’01)(Dummy(ind_compendation=0 ’01),

Dummy (ind_nomination=0 ’01)) is a dummy variable that equals to one if the firm did not have a fully independent

audit(compensation, nomination) committee on the board in 2001, and zero otherwise. Other variables are defined in

the Appendix. ***, **, and * indicate statistical significance at the 1%, 5%, and 10% levels, respectively. T-statistics

are in parentheses below parameter estimates. The t-statistics are adjusted for heteroscedasticity.

Dependent Variable: Cash Holdings (1) (2)

Dummy(pct_ind<0.5 '01) * Post-SOX

0.050***

0.048***

(3.82)

(3.59)

Dummy(ind_audit=0 '01) * Post-SOX

0.023**

(2.37)

Dummy(ind_compensation=0 '01) * Post-SOX

-0.020*

(-1.91)

Dummy(ind_nominating=0 '01) * Post-SOX

-0.008

(-1.00)

Log firm size * Pre-SOX

-0.221***

-0.221***

(-16.99)

(-16.96)

Log firm size * Post-SOX

-0.209***

-0.209***

(-16.36)

(-16.4)

Market to book * Pre-SOX

0.030***

0.030***

(7.12)

(7.14)

Market to book * Post-SOX

0.056***

0.055***

(9.12)

(9.09)

Cash flow /net assets * Pre-SOX

0.172

0.171

(1.52)

(1.51)

Cash flow/net assets * Post-SOX

0.352***

0.355***

(3.1)

(3.13)

NWC/net assets * Pre-SOX

-0.537***

-0.537***

(-8.56)

(-8.56)

NWC/net assets * Post-SOX

-0.500***

-0.502***

(-7.06)

(-7.08)

Capex/net assets * Pre-SOX

-0.185*

-0.186*

(-1.70)

(-1.71)

Capex/net assets * Post-SOX

-0.050

-0.051

(-0.37)

(-0.37)

Leverage * Pre-SOX

0.311***

0.310***

(6.71)

(6.70)



Leverage * Post-SOX

0.234***

0.234***

(4.50)

(4.48)

Industry sigma * Pre-SOX

0.004

0.004

(1.38)

(1.35)

Industry sigma * Post-SOX

0.001

0.001

(0.69)

(0.60)

Dividend dummy * Pre-SOX

0.052***

0.052***

(5.19)

(5.18)

Dividend dummy * Post-SOX

0.033***

0.033***

(3.08)

(3.08)

R&D/sales * Pre-SOX

0.489***

0.491***

(2.70)

(2.71)

R&D/sales * Post-SOX

0.202

0.214

(1.09)

(1.15)

Acquisition activity * Pre-SOX

-0.156***

-0.158***

(-3.19)

(-3.23)

Acquisition activity * Post-SOX

-0.271***

-0.274***

(-3.45)

(-3.48)

Rated debt dummy * Pre-SOX

0.015

0.016

(1.04)

(1.09)

Rated debt dummy * Post-SOX

0.030*

0.031*

(1.86)

(1.94)

Industry fixed effects

Yes

Yes

Year fixed effects

Yes

Yes

Firm fixed effects

Yes

Yes

Observations

6715

6712

Adjusted R2 0.86 0.86



Table 3: Board Independence and Cash Holdings Conditional Upon Financial Constraints

This table shows the results of regressions of cash holdings on board independence conditional upon financial constraints.

The sample includes all the firm years from 1996 to 2006 in the full sample. The dependent variable is the ratio of cash plus

marketable securities to net assets, where net assets is the book value of total assets minus cash plus marketable securities.

Dummy(pct_ind<0.5 ’01) is a dummy variable that equals to one if the firm did not have a majority of independent directors

on the board in 2001, and zero otherwise. Proxies for financial constraints used are the zero total payout dummy variable (a

dummy variable equals to one if the firm’s total payout ratio is zero, and zero otherwise), the no bond rating dummy variable

(a dummy variable equals to one if the firm does not have a bond rating but reports long-term debt, and zero otherwise), the

no commercial paper rating dummy variable (a dummy variable equals to one if the firm has no commercial paper rating but

reports short-term debt, and zero otherwise), and the total assets below the sample median (a dummy variable equals to one

if the firm’s total assets are below the sample median, and zero otherwise). Other variables are defined in the Appendix. ***,

**, and * indicate statistical significance at the 1%, 5%, and 10% levels, respectively. T-statistics are in parentheses below

parameter estimates. The t-statistics are adjusted for heteroscedasticity.

(1) (2) (3) (4)

Dependent Variable: Constrained Constrained Constrained Constrained

Cash Holdings if zero total payouts if no bond rating if no cp rating if small

Financially constrained dummy 0.005 -0.088*** -0.037*** -0.086***

(0.43) (-4.24) (-3.90) (-7.70)

Dummy(pct_ind<0.5 '01) * Post-SOX 0.041*** 0.069*** -0.086*** 0.052***

(3.42) (4.32) (4.80) (2.87)

Financially constrained dummy* 0.043 -0.061*** -0.058*** -0.007

Dummy(pct_ind<0.5 '01) * Post-SOX (1.26) (-2.61) (-2.65) (-0.27)

Log firm size * Pre-SOX -0.220*** -0.217*** -0.219*** -0.242***

(-17.00) (-16.89) (-16.87) (-17.82)

Log firm size * Post-SOX -0.209*** -0.204*** -0.208*** -0.231***

(-16.41) (-16.11) (-16.27) (-17.11)

Market to book * Pre-SOX 0.030*** 0.029*** 0.030*** 0.029***

(7.07) (7.02) (7.11) (7.06)

Market to book * Post-SOX 0.056*** 0.056*** 0.055*** 0.055***

(9.09) (9.11) (9.06) (9.05)

Cash flow /net assets * Pre-SOX 0.171 0.187* 0.178 0.164

(1.51) (1.67) (1.58) (1.46)

Cash flow/net assets * Post-SOX 0.358*** 0.343*** 0.348*** 0.328***

(3.17) (3.03) (3.08) (2.91)

NWC/net assets * Pre-SOX -0.536*** -0.527*** -0.542*** -0.516***

(-8.55) (-8.41) (-8.67) (-8.45)

NWC/net assets * Post-SOX -0.502*** -0.485*** -0.517*** -0.486***

(-7.08) (-6.78) (-7.31) (-7.02)

Capex/net assets * Pre-SOX -0.186* -0.186* -0.190* -0.178*

(-1.70) (-1.71) (-1.74) (-1.65)

Capex/net assets * Post-SOX -0.051 -0.052 -0.070 -0.042

(-0.38) (-0.39) (-0.52) (-0.31)



Leverage * Pre-SOX 0.311*** 0.352*** 0.319*** 0.311***

(6.72) (7.54) (6.9) (6.75)

Leverage * Post-SOX 0.234*** 0.285*** 0.247*** 0.231***

(4.47) (5.46) (4.75) (4.45)

Industry sigma * Pre-SOX 0.004 0.004 0.004 0.004

(1.41) (1.35) (1.37) (1.12)

Industry sigma * Post-SOX 0.001 0.001 0.001 0.001

(0.69) (0.57) (0.78) (0.75)

Dividend dummy * Pre-SOX 0.054*** 0.052*** 0.052*** 0.053***

(4.79) (5.17) (5.16) (5.31)

Dividend dummy * Post-SOX 0.038*** 0.032*** 0.030*** 0.033***

(3.19) (3.04) (2.84) (3.12)

R&D/sales * Pre-SOX 0.486*** 0.514*** 0.500*** 0.484***

(2.68) (2.85) (2.75) (2.68)

R&D/sales * Post-SOX 0.199 0.196 0.187 0.194

(1.07) (1.06) (1.01) (1.05)

Acquisition activity * Pre-SOX -0.156*** -0.156*** -0.159*** -0.149***

(-3.18) (-3.24) (-3.25) (-3.08)

Acquisition activity * Post-SOX -0.272*** -0.264*** -0.265*** -0.264***

(-3.46) (-3.38) (-3.38) (-3.40)

Rated debt dummy * Pre-SOX 0.015 -0.066*** 0.014 0.006

(1.03) (-2.74) (0.98) (0.44)

Rated debt dummy * Post-SOX 0.030* -0.056** 0.031** 0.024

(1.85) (-2.29) (1.96) (1.51)

Industry fixed effects Yes Yes Yes Yes

Year fixed effects Yes Yes Yes Yes

Firm fixed effects Yes Yes Yes Yes

Observations 6715 6715 6715 6715

Adjusted R2 0.86 0.86 0.86 0.86



Table 4: Board Independence and External Monitoring

This table shows the regression results analyzing the interaction effect of external monitoring and board independence

on cash holdings. The sample includes all the firm years from 1996 to 2006 in the full sample. The dependent variable

is the ratio of cash plus marketable securities to net assets, where net assets is the book value of total assets minus cash

plus marketable securities. Dummy(pct_ind<0.5 ’01) is a dummy variable that equals to one if the firm did not have a

majority of independent directors on the board in 2001, and zero otherwise. Column (1) uses shareholdings by

institutional block-holders (defined as institutional shareholders with more than 5% holdings) and column (2) uses

shareholdings by public pension funds as proxies for external monitoring/pressure. Column (3), uses GIM-Index as the

proxy for external monitoring/pressure. Low monitoring is a dummy variable that equals one for firms that fall in the

bottom quartile of respective monitoring dimension and high monitoring is a dummy variable that equals one for firms

that fall in the top quartile of respective monitoring dimension. Other variables are defined in the Appendix. ***, **,

and * indicate statistical significance at the 1%, 5%, and 10% levels, respectively. T-statistics are in parentheses below


Dependent variable: (1) (2) (3)

Cash Holdings Block Holders Public Pension Funds GIM-Index

Low Monitoring* 0.051** 0.054** 0.104**

Dummy(pct_ind<0.5 '01) * Post-SOX 2.35 (2.44) (2.14)

High Monitoring* -0.025 0.015 -0.007

Dummy(pct_ind<0.5 '01) * Post-SOX (-0.68) (0.51) (0.31)

Log firm size * Pre-SOX -0.220*** -0.221*** -0.211***

(-16.78) (-16.86) (-15.77)

Log firm size * Post-SOX -0.209*** -0.209*** -0.203***

(-16.22) (-16.23) (-15.14)

Market to book * Pre-SOX 0.030*** 0.029*** 0.029***

(7.07) (7.06) (6.84)

Market to book * Post-SOX 0.056*** -0.056*** 0.054***

(9.12) (9.15) (8.20)

Cash flow /net assets * Pre-SOX 0.177 0.174 0.087

(1.56) (1.53) (0.76)

Cash flow/net assets * Post-SOX 0.346*** 0.342*** 0.292**

(3.05) (3.01) (2.39)

NWC/net assets * Pre-SOX -0.538*** -0.539*** -0.566***

(-8.56) (-8.57) (-8.67)

NWC/net assets * Post-SOX -0.501*** -0.495*** -0.528***

(-7.05) (-6.97) (-7.07)

Capex/net assets * Pre-SOX -0.191* -0.193* -0.141

(-1.75) (-1.77) (-1.26)

Capex/net assets * Post-SOX -0.045 -0.044 0.074

(-0.33) (-0.32) (0.52)

Leverage * Pre-SOX 0.311*** 0.312*** 0.271***



(6.68) (6.70) (5.72)

Leverage * Post-SOX 0.234*** 0.234*** 0.201***

(4.49) (4.51) (3.67)

Industry sigma * Pre-SOX 0.005 0.005 0.004

(1.51) (1.50) (1.42)

Industry sigma * Post-SOX 0.001 0.001 0.002

(0.61) (0.68) (1.15)

Dividend dummy * Pre-SOX 0.054*** 0.055*** 0.049***

(5.28) (5.40) (4.77)

Dividend dummy * Post-SOX 0.033*** 0.032*** 0.026**

(3.11) (3.02) (2.39)

R&D/sales * Pre-SOX 0.494*** 0.490*** 0.430**

(2.72) (2.70) (2.18)

R&D/sales * Post-SOX 0.197 0.197 0.206

(1.06) (1.06) (1.05)

Acquisition activity * Pre-SOX -0.157*** -0.158*** -0.157***

(-3.20) (-3.22) (-3.22)

Acquisition activity * Post-SOX -0.268*** -0.267*** -0.262***

(-3.41) (-3.39) (-3.14)

Rated debt dummy * Pre-SOX 0.014 0.014 0.011

(0.94) (0.95) (0.82)

Rated debt dummy * Post-SOX 0.027* 0.028* 0.029*

(1.70) (1.71) (1.74)

Industry fixed effects Yes Yes Yes

Year fixed effects Yes Yes Yes

Firm fixed effects Yes Yes Yes

Observations 6688 6688 6152

Adjusted R2 0.86 0.86 0.85



Table 5: Board Independence and the Value of Cash

This table shows the regression results for the value regression on board independence. The sample includes all the firm

years from 1996 to 2006 in the full sample. The dependent variable is the excess stock return during fiscal year t.

Dummy(pct_ind<0.5 ’01) is a dummy variable that equals to one if the firm did not have a majority of independent

directors on the board in 2001, and zero otherwise. Other variables are defined in the Appendix. All variables except

dummy variables are scaled by the lagged market value of equity. ∆X is notation for the one-year change. ***, **, and *

indicate statistical significance at the 1%, 5%, and 10% levels, respectively. T-statistics are in parentheses below


Dependent variable: Excess stock return

Cash

5.028***

(2.89)

Post-SOX dummy

-0.052***

(-3.62)

Dummy(pct_ind<0.5 '01) * Post-SOX

0.004

(0.16)

Post-SOX * ∆Cash

-1.604

(-1.57)

Dummy(pct_ind<0.5 '01) * Post-SOX * ∆Cash

2.184*

(1.87)

arnings

1.566***

(5.97)

∆Net Assets

0.345***

(3.26)

∆R&D

-0.826

(-0.61)

∆Interest

-14.805***

(-5.35)

∆Dividend

0.623

(1.44)

Lagged Cash

0.507***

(4.06)

Leverage

0.106

(1.57)

New Financing

0.206

(0.48)

Lagged Cash * ∆Cash

-9.139***

(-3.01)

Leverage * ∆Cash

-2.634

(-0.80)

Observations

3979



Adjusted R2 0.18

Appendix: Definition of Variables

Variables Definition

Dependent variables

Cash holdings Ratio of cash plus marketable securities to net assets, where net

assets is the book value of total assets minus cash plus marketable

securities

CHE/(AT-CHE)

Excess stock return

𝑟𝑖𝑡 − 𝑅𝑖𝑡𝐵 , where rit is the stock return for firm i during fiscal year t

and 𝑅𝑖𝑡𝐵 is stock i's benchmark return at year t. One calculates the

benchmark return by annualizing the monthly returns from the

Fama and French 25 size and book-to-market portfolio the firm

belongs to each month.

Control variables

Dummy(pct_ind<0.5 '01) An indicator variable that equals to one if the firm did not have a

majority of independent directors on the board in 2001, and zero

otherwise

Dummy(ind_audit=0 '01) An indicator variable that equals to one if the firm did not have a

fully independent audit committee on the board in 2001, and zero

otherwise

Dummy(ind_compensation=0 '01) An indicator variable that equals to one if the firm did not have a

fully independent compensation committee on the board in 2001,

and zero otherwise

Dummy(ind_nomination=0 '01) An indicator variable that equals to one if the firm did not have a

fully independent nomination committee on the board in 2001, and

zero otherwise

Post-SOX An indicator variable that equals one if the observation is in the

period at or after 2003 and zero otherwise

Pre-SOX An indicator variable that equals one if the observation is in the

period before 2003 and zero otherwise

Log firm size Natural logarithm of the book value of net assets measured in 2006

dollars

ln(AT-CHE)

Market to book Ratio of the book value of net assets minus the book value of equity

plus the market value of equity to the book value of net assets

(AT-CHE-CEQ+CSHO*PRCC_F)/(AT-CHE)

Cash flow /net assets Ratio of earnings after interest, dividends and taxes but before

depreciation to the book value of net assets

(OIBDP-XINT-TXT-DVC)/(AT-CHE)



NWC/net assets Ratio of net working capital to the book value of net assets

(ACT-LCT-CHE)/(AT-CHE)

Capex/net assets Ratio of capital expenditures to the book value of net assets

CAPX/(AT-CHE)

Leverage Sum of long-term debt and debt in current liabilities divided by the

book value of net assets

(DLTT+DLC)/(AT-CHE)

Industry sigma Mean of the standard deviations of cash flow/net assets over 10

years for firms in the same industry, where industries are defined by

two-digit SIC codes

Dividend dummy An indicator variable that equals to one in years in which a firm

pays a common dividend (DVC) and zero otherwise

R&D/sales Ratio of research and development expenditure to sales. If research

and development expenditure is missing, the ratio is set equal to

zero.

XRD/SALE

Acquisition activity

Ratio of expenditures on acquisitions to the book value of net assets

AQC/(AT-CHE)

Rated debt dummy An indicator variable that equals one if S&P credit rating

(SPLTICRM) is between "C" and "AAA" and zero otherwise

Zero total payouts An indicator variable equals to one if the firm’s total payout ratio

(the ratio of dividends plus share repurchases to operating income)

is zero, and zero otherwise

Total payouts = (DVC+PRSTKC)/OIBDP

No bond rating An indicator variable that equals to one if the firm does not have a

bond rating (DLTT) but reports long-term debt (SPLTICRM), and

zero otherwise

No cp rating An indicator variable equals to one if the firm has no commercial

paper rating (DLC) but reports short-term debt (SPSTICRM), and

zero otherwise

Small An indicator variable equals to one if the firm’s total assets (AT)

are below the sample median, and zero otherwise

Block Holders Shareholdings by institutional block-holders (defined as

institutional shareholders with more than 5% holdings)

Public Pension Funds Shareholdings by public pension funds

GIM-Index The Gomper, Ishi and Metricks (2003) index. It is calculated by

counting the number of antitakeover provisions of the firm. It varies

from 0 to 24.

Cash Cash plus marketable securities

CHE



Dividend Common dividend

DVC

Net assets Book value of total assets minus cash plus marketable securities

AT-CHE

Interest XINT

Earnings Earnings before extraordinary items plus interest, deferred tax

credits, and investment tax credits

IB+XINT+TXDI+ITCI

New Financing Sales of common and preferred stock minus stock repurchase plus

issuance of long-term debt minus long-term debt reduction

SSTK-PRSTKC+DLTIS-DLTR

R&D Research and development expenditure. If research and

development expenditure is missing, it is set equal to zero.

XRD

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